"Why did yields surge?" possible answer to why it took so long for dollar to rally

Dollar decisively showed its heels yesterday to sterling, euro and other currencies, leaving them behind in the dust wondering how this happened. The move of the dollar yesterday coincided with a break of the yields on 10 year US treasuries above 3.05% - the highest level since July 2011. The big question now becomes “why USD did not rally earlier on the back of higher yields?” It all comes down to why yields on US treasuries climbed higher; is this because investor outlooks on the US economy have improved, or is it because the appetite for treasuries is slumping?

Projections of the Congressional Budget Office foresee the US budget deficit at 4.6% of GDP in 2019 and 2020. The International Monetary Fund even calculated that on the current path the US debt-to-GDP ratio will surpass that of the Eurozone problem child, Italy, by 2023. Additionally, the Federal Reserve will shrink their portfolio of treasuries by 1.5-1.7% over the same years, with the quantitative tightening reaching its peak in the fourth quarter of 2018. Add the divestment by China in dollar debt and the decreasing dependence of central banks around the globe on dollars as currency reserves (shown in the latest IMF COFER data) and a clear trend emerges; fewer potential buyers for US debt while the growing fiscal deficit will increase its supply.

This nuance can explain why it took so long for the dollar to rally on the back of increased yields. The reason for higher yields coincide with factors that erode trust in the dollar and US debt instruments. Hardly an undivided blessing.

If we assume that the source of the recently risen US interest rates matters, then the argument of interest rate differentials between the US and other countries loses much of its punch. Other developments then become more likely candidates for driving the recent global dollar strength, like macro factors. This is not entirely unimaginable as the US surprise index outpaced that of most other countries so far in 2018 (chart 2).